MarketSci Looks at the VIX 5% Rule

By Bill Luby | January 08, 2009 | 1:17 PM |  0 Comments

MarketSci is a blog that somehow manages to ponder the same sort of issues that I like to chew on. Fortunately, MarketSci does more than ponder. In fact, much like the approach favored by Quantifiable Edges, MarketSci seems to aspire to being the mythbusters of the investment world.

This week MarketSci has particularly interesting series of items on its plate: the Trading Markets 10 Trading Rules. One by one, MarketSci is taking a data-driven approach to determining the usefulness of each of the Trading Markets rules.

In today’s installment, Testing TM Rule #5: the VIX 5% Rule, MarketSci examines the popular TradingMarkets 5% rule that I discussed in 2007 in a post with the unlikely title of The TradingMarkets 5% VIX Rule. In short, MarketSci comes down on the side of the usefulness of the 5% rule as a defensive measure. The full analysis is worth clicking through for, as are the other installments in the analysis of the ten trading rules, most of which are consistent with my own thinking and several of which should probably be part of every trader’s arsenal.

Possible Post-Gap Accumulation

By Jeff Pietsch | January 08, 2009 | 12:57 PM |  0 Comments

After a near 1% gap down at the open, the S&P500 (AMEX: SPY) has found support just above S1 (SPY $89.80) and the VIX appears to be stabilizing near 43. While the daily VWAP has mostly flattened, positive Tick and AD line slopes are suggestive of possible accumulation at this level. However, Energy (XLE +0.46%) is once again the day's big winner, volume is light, down volume continues to outpace, and the big jobs report is out tomorrow, so I'll be playing it safe into the close even as I trim hedges a tad here.

Reading:

o Quant Edges - Weakness Begets Weakness
o MarketSci - TM's VIX 5% Rule

Precious Metals or Industrial Commodities?

By Chip Hanlon | January 08, 2009 | 12:55 PM |  0 Comments

In sifting through the commodity wreckage, should investors favor precious metals or other industrial commodities? Fundamentally, I personally think the long-term case for precious metals is particularly compelling but Steve Saville penned some interesting short-term thoughts in his note to clients last night:

During the final 4 months of last year gold rocketed upward relative to most other commodities. We expect gold's out-performance to continue on a longer-term basis, but during the first few months of this year the monetary metal will probably give back some of last year's spectacular gains relative to the base metals, other precious metals, oil and the grains. This partial retracing of recent large gains will, we think, be prompted by the mistaken belief that the economic consequences of the financial crisis have been fully discounted in current prices.

The following chart shows gold's moon-shot relative to the Industrial Metals Index (GYX) and the preliminary signs of a short-term trend reversal.

As an aside, relative weakness in gold bullion over the next few months should not prevent the gold sector of the stock market from being one of the strongest equity sectors. This is because the gold sector still has a lot of catching up to do.

Testing TM, Rule #5: the VIX 5% Rule

By Michael Stokes | January 08, 2009 | 11:52 AM |  0 Comments

This is the fourth part of this week’s series on TradingMarket.com’s 10 Trading Rules. In this post, I’ll look at the fifth in TM’s list: the VIX 5% rule.

TM advocates not being long the market when the VIX is more than 5% below its 10-day moving average because this has historically indicated that the market was overbought. Per TM: “if you only follow one market sentiment indicator, it should be the 5% rule”. Ahem.

[logarithmically-scaled]

The graph above shows a strategy that is long the S&P 500 from today’s close when the VIX closes above TM’s threshold (red), versus a buy and hold approach (blue), and for comparison’s sake, another that is long when the VIX closes below TM’s threshold (green), from early 1990.

Recall that TM’s threshold is 5% below the 10-day simple moving average of the VIX. This is a proof of concept so these results are frictionless (ignore transaction costs and slippage) and do NOT account for return on cash.

For the number lovers:

TM’s 5% rule cuts out about 25% of the time in the market.

During that 25% of days, the market has generally traded neutral to bearish. This wasn’t true in the late 1990’s, but intermediate-term overbought indicators (like this one) in general didn’t work well in those go-go days (a product of euphoria).

I think it’s important to note that trading above the 5% threshold hasn’t necessarily been bullish for the market (just look to the bear market of the early 2000’s to confirm that), but that isn’t the way TM postured the rule. It was postured as a defensive indicator, not an offensive one.

So do I agree that “if you only follow one sentiment indicator, it should be the 5% rule”? No, on two accounts: (a) no one should be following just one market sentiment indicator, one strategy, one anything – that’s just foolhardy, and (b) I think that there are more effective indicators that play in this intermediate timeframe.

Having said that, as a defensive indicator, I think TM’s 5% rule has wings.

Happy Trading,
ms